Bill Thomas’s Revenge

Democrats now face his magically disappearing tax cuts.

Gary Andres

July 26, 2010, Vol. 15, No. 42

Bill Thomas loved schemes. The former California congressman, who chaired the House Ways and Means Committee from 2001 to 2006, practiced the arcane art of parliamentary procedure like a wizard, concocting potions that turned his political opponents into hapless frogs.

Thomas sometimes even kept the details of his grandiose plans a secret from allies. He once pulled Majority Leader Dick Armey aside on the House floor and whispered that he had a new idea about how to pass a controversial piece of legislation.

“Great,” Armey said. “What is it?”

“I can’t tell you,” Thomas said with a twinkle in his eye. “But you’ll love it.”

Thomas understood Congress’s dark side. His lengthy House tenure—28 years​—convinced him that there is a gene in congressional DNA that leads lawmakers to kick the can down the road rather than make tough choices.

The behavior of the current Democratic majority is a testament to Thomas’s understanding. Fail to pass a federal budget? No problem: We’ll muddle through. Let unemployment benefits lapse? Blame the Republicans. Funding the war in Afghanistan? Hey, there’s always money somewhere. A growing list of federal agencies and programs crying out for reform and reauthorization? Aw, just extend current law for another few months. This list could go on.

Thomas’s crowning achievements were the 2001 and 2003 tax cut bills, and both included a procedural tripwire that set in motion a ticking political time bomb.

Republican leaders wanted the tax cuts to be permanent, but in order to get the votes for enactment of both bills, they used the budget process known as reconciliation. While this meant the legislation could pass the Senate with only 51 votes, it also limited the policy changes in the bill to a finite period. Hence the 2001 and 2003 tax cuts are scheduled to expire at the end of 2010—a long way off, many thought back then.

But Thomas also knew a future Congress would face an unavoidable deadline and a tough political choice. Doing nothing assures an automatic tax increase—and not a small one. Failure to act will actually produce the largest tax hike in history. And in about six months, the long fuse Thomas lit nearly ten years ago will ignite an explosion.

On January 1, 2011, the top individual tax rate jumps from 35 percent to 39.6 percent. The child tax credit gets slashed in half—from $1,000 to $500. Taxes on dividends snap back to 39.6 percent from their current 15 percent rate. Capital gains rates jump from 15 percent to 20 percent. The current lowest tax bracket increases by 50 percent—from 10 percent to 15 percent. The estate tax, which phased down to zero this year, surges to a whopping 55 percent. Taxes on married couples increase, and the dependent care and adoption tax credits get reduced. This is just a sampling.

Normally modifying tax law requires major congressional action. But because of the way the 2001 and 2003 legislation was structured, if Congress does nothing, all these taxes increase automatically. Boom.

Several participants in the negotiations surrounding the passage of the two tax bills say Thomas’s flair for creative legislation helped seal the deals. One former senior administration official recalls a meeting on the Truman Balcony at the White House with Republican congressional leaders when the 2003 bill had hit a snag in the Senate. “Even though Republicans controlled the majority in the Senate, several senators wanted to cut the [amount of money] dedicated to tax cuts in half,” he told me.

This created a problem. To help spur economic growth after the 9/11 attacks, President Bush wanted to accelerate the individual rate reductions first passed in 2001. He also sought to cut the tax rate on dividends. House Republicans had a strong interest in reducing the capital gains tax as well. Doing all this, along with addressing other issues such as the Alternative Minimum Tax (AMT), the marriage penalty, and child tax credits would cost hundreds of billions, more than the Senate was willing to swallow.

Thomas was uncharacteristically quiet during the contentious meeting, but the wheels were turning. After hearing the Senate problem, Thomas broke his silence. “I think I have a way of doing this,” he said. He then proceeded to describe a plan that shifted some implementation dates and phased in other provisions, making the numbers fit into the Senate budget window.

While everyone’s preference was to make all these tax cuts permanent, Thomas and others were trying to do the best they could under the political constraints. He proposed to use as much money as possible to enact the most simulative yet politically vulnerable tax reductions—accelerating the individual marginal rates and cutting taxes on dividends and capital gains. He felt he could phase out other more politically popular provisions, knowing a future Congress would have a tough time not extending these tax cuts.

After listening to the Thomas scenario, Bush was convinced. “I’m with Bill,” he told the other congressional leaders.

“[Thomas’s] main goal was to protect what many thought was the most needed but vulnerable pieces of the package—the individual marginal rate reductions,” David Hobbs, former assistant to the president for legislative affairs told me. “Protecting the middle class from the AMT, the child credit, and marriage penalty relief had broad bipartisan support,” he notes. “By structuring the bill the way he did, Thomas got the biggest bang for the buck and did the most with what he had to work with.”

He also created a huge political headache for today’s Democrats, already nervous about November’s elections.

President Obama says he wants to shield families making less than $250,000 from higher rates. Treasury Secretary Timothy Geithner announced the administration wants the capital gains increase to go no higher than 20 percent.

Yet granting the administration’s wish requires tough decisions by Congress on a broad range of thorny tax policy questions. First, how to pay for these changes? The Congressional Budget Office projects revenue flows into the government based on current laws. And right now, with these tax rates set to rise, so are revenues. Exempting certain groups requires billions in offsets (i.e., higher taxes on someone else) or government debt balloons further.

Neither option is good.

“We’re talking about $411 billion just for offsetting for the next two years,” lamented Representative Earl Blumenauer (D-Oregon), a member of the tax-writing House Ways and Means Committee.

And deciding to exempt all but “the rich” (incomes over $250,000 per year) is not as easy as it sounds. Many small business owners file as individuals and will get hit by these higher rates—not a popular political move or sound economic policy with the prospect of a double dip recession.

Bill Thomas is no longer in Congress, but the remnants of his strategic political thinking endure. Leave it to one of the House’s best legislative schemers to create a nasty political problem for the Democrats long after he retired.

Gary Andres is vice chairman of public policy and research at Dutko Worldwide in Washington, D.C., and a regular contributor to The Weekly Standard online.